Are stock buybacks really worth it?

With many companies amassing cash on their balance sheets, and with the economic recovery faltering, many companies are resorting to the familiar tactic of buying back their shares in the open market. Buybacks are designed to buoy a company’s stock price, and management likes them because they boost earnings per share by reducing the number of outstanding shares in the market. That, in turn, helps to goose management’s stock-based compensation.

During the previous buyback wave from 2004 through 2008, the members of the current Standard & Poor’s 500 repurchased more than $1.80 trillion worth of their own shares, which represents $90 billion per quarter.

The magazine examined the buybacks of 461 companies in the Standard & Poor’s 500 Index from 2004 to 2008 and found that investing in companies that buy back shares may not yield as much value as investing in good businesses.

One observation based on the research is that the 29 companies that did not repurchase any stock during this period delivered median total shareholder return (TSR) of positive 40%, while the overall S&P 500 index was down 19%.

Companies that offer great investment opportunities typically don’t have to buy back shares. More important, the magazine’s research found that the timing of buybacks is usually off. In other words, rather than buying low and selling high, most companies buy their own shares near the peak of the market. That’s ironic because companies usually justify buyback programs by claiming their shares are undervalued. It also implies that companies are deciding to buy their shares based on available cash flow, not on the investment merits.In other words, they buy their shares because they have the money, not necessarily because it makes sense at the time.

Have buybacks improved your investment returns?

I’ll have more on the Wal-Mart buyback and what it says about the overall economy in tomorrow’s Chronicle column.